Stable prices (idea)

Stable prices are crucial for confidence, facilitating existing conracts and enabling the exchange rate system to function smoothly, whereas persistently rising prices cause problems within most sectors of the economy.

If prices are continually rising entrepreneurs are hesitant to enter into contracts as they cannot work out the long-run results of their investments. This is often compounded further by the problems of changing exchange rates and interest rates which often accompany inflation. It is easiest to work within a stable economic environment. Indeed economists often discuss menu costs as the associated effects of inflation on business. These costs consist of aspects such as vending machine alterations, the costs of printing revised price lists, the time spent renegotiating and so on.

Similarly, inflation affects those who are not economically active. If price changes are not monitored, pensioners, students and those reliant on state benefits suffer, since their fixed incomes need to be revised to be kept in line with price increases. As a result, many aspects of economic activity are now index linked to allow for inflation. For example, savings, business contrats and pensions can all be adjusted in the light of inflation. All that is needed is a reliable price index. Consequently, since 1947, British governments have monitored price increases via the retail price index(RPI).

Note: this write-up applies specifically to the British economy, and on a wider scale to all largely capitalist economies. Communist economies have different objectives- namely equality. (At least that's what they say).